Dr Anders Kjellman - Nuclear Finance

Forms of asset versus liability management

Modern banks have become more likely to undertake co-ordinated management of both sides of the balance sheet, rather than focusing on just the asset side. The main concerns and objectives of a bank manager on the asset and liability sides are summarised in Table 2.2. below (see Casu et al., 2006: 226).

Table 2.2. Forms of asset management versus liability management

The co-ordinated and simultaneous decision in financing investment is the essence of asset-liability management. What is asset-liability management in practice? Sinkey (1998) identified a three-stage approach to balance-sheet co-ordinated management. Stage 1: global or general approach, stage 2: identification of specific components, and stage 3: balance sheet generates profit and loss account. Policies to achieve these objectives should include:

Loan quality,

Matching maturities,

Generating fee income and service charges,

Control of non-interest operating expenses,

Tax management, and

Capital adequacy.

It is important to look at and manage both sides of a bank’s balance sheet. For modern banks, the goal is to manage assets and liabilities in a way that maximises profits while being generally ‘safe and sound’. Prudence banking is needed due to the special role that banks have in the economy and the potential ‘domino’ effects that a bank’s failure may cause to the financial sector as a whole. In doing so, bank managers rely on information revealed by periodic financial reports produced by various accounting systems.

We believe that the information bank managers have about the banking business is not as realistic as the information that a manufacturing firm has. The basic risks of the banking business are still the same ones that affect the lending and the funding of lending. The risks are related to real estate, venture capital and risk business, the maturity of funding, the marginal of rent interest, competitors, and the technological skills of the banking industry and the managers themselves.

More about the complexity of banking

The strengthening of credit risk and liquidity management are pivotal in banking because the capital structure of a retail bank is about five to ten times more vulnerable than a typical capital structure of a manufacturing firm. We have seen difficult and complex problems, and some these problems are external while others are self-inflicted internal bank problems at the level of the banks and bank managers. Here we constitute some banking business complexities, which have different effects for banks and for bank managers in banking arenas. We believe that there are more external complexities (out-bank) for banks than internal ones.

External complex challenges for banks:

uncertain economy,

unfair competition,

unclear and disloyal governments and other authorities,

spontaneous bank mergers,

shadow banking; new unknown competitors,

payment platforms,

new bank technology, and

other challenges.

Internal challenges for bank managers:

bad and untruthful customers,

compliance problems,

lending to new and unknown customers,

unclear papers and illegal decisions,

difficult to forecast the economy for bank and possibilities of customers, untruthful managers/colleagues and employees,

complex bank service products, and

other internal challenges.

There are many other complex issues in banking. However, these rules of thumb may help you as a bank manager to reduce some of the complexity issues. In order to help your customers, you may like to refer to the following guidelines:

Indebtedness of households should not be too much over 100 percent of disposable income of five years.

A magnificent lifestyle and too many credit cards is not recommended.

Too high prices of real estates, should raise concern.

Unexpected changes in the values of firm assets are common so a lower valuation is recommended.

Credits for unknown projects of firms is not advisable!

The competition situation and different levels and dimensions of banks will affect how a bank manager conducts his/her operational work. Still, the complexity and interaction between different factors and measures are, in reality, hard to understand. It is a difficult area to master and obviously a great field of tension. The seeds of crisis can often be found in the fact that this is an area where you can easily go wrong. All the participants in the financial industry, from central bankers and authorities to bankers and customers, have repeatedly taken wrong turns throughout history! – and we can expect them to do that again!

However, let’s start with an overview of the financial market structure and the functions of Financial Intermediators.

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